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European Central Bank faces tough choices

Updated at: 12/04/2013 10:06 AM
By DAVID McHUGH

(AP) FRANKFURT, Germany - The European Central Bank says it stands ready to do more, if needed, to boost a weak recovery. But each possible step faces significant drawbacks or even political opposition.

Analysts don’t expect the ECB’s rate-setting council, which meets Thursday, to repeat last month’s surprise cut to the benchmark interest rate to 0.25 percent from 0.50 percent. But they think it might take action in coming months, particularly if the recovery weakens further. The focus will be on ECB President Mario Draghi at his news conference for further clues.

The eurozone economy grew only 0.1 percent in the third quarter, and unemployment is a painful 12.1 percent. Inflation, at 0.9 percent, is close to a four-year low, far short of the bank’s goal of just under 2 percent, and a token of how slow the recovery is.

Here are four things the ECB could do_ and what their downsides are.

CUT RATES

The ECB could slice its refinancing rate _ what banks pay to borrow from the ECB _ from 0.25 percent to close to zero, or even zero itself. That could help lower the euro’s exchange rate _ which would make eurozone exports cheaper and help companies sell more abroad.

But the big problem is that rates are already low _ and banks are not passing them on to businesses as they remain cautious about lending. That is choking off credit, a key factor holding back growth in the 17-country currency bloc.

"The transmission mechanism is still broken," said analyst Petr Zemcik at Moody’s Analytics.

The ECB could also cut the interest rate it pays on deposits from private-sector banks, currently at zero, to negative. Charging banks to hold their money would penalize them for hoarding funds and push them to lend. But banks could also pass the cost on by increasing their own lending rates _ the opposite of what the ECB wants.

MAKE LOANS

The ECB could give banks long-term loans at low rates in hopes they use the money for loans.

The ECB did this before, giving about 1 trillion euros ($1.36 trillion) in three-year loans. Yet the money didn’t do much to boost credit. Some banks used it to load up on interest-bearing government bonds. If the ECB tries this again, it could tie banks’ access to the money to a promise to actually lend it onward.

BUY BONDS

If things worsen drastically, the ECB could, as a central bank, actually create new euros _ and then use those euros to buy bonds. That would drive down longer-term bond market interest rates. It would also increase the supply of money in the economy. The U.S. Federal Reserve and the central banks of England and Japan have all done this _ and their economies are growing faster.

There’s a problem, however: companies in Europe mostly borrow from banks, not bond markets, as they do in the U.S. So driving down bond market rates doesn’t help them as much.

In practical terms, it could be difficult to buy bonds across 17 different government debt markets.

And politically, creating new money could run into opposition from Germany, where economists and politicians say the central bank’s powers shouldn’t be used to paper over the eurozone’s troubles and relieve governments of the need to reform their economies to get growth going.

Germany’s central bank actually has only one vote on the 23-member ECB council. But the ECB is wary of antagonizing public opinion in Germany, the eurozone’s biggest member.

FIX THE BANKS

The ECB is conducting a yearlong review of eurozone banks’ finances to find the weak ones and, if need be, force them to restructure or raise new capital. Yet Europe is still working on an EU-wide agency that would have the power to carry out such restructurings. So it’s not clear if the ECB’s efforts will lead to a thorough housecleaning.

And it will take until late next year. If the recovery weakens much further, the eurozone won’t have that much time.